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Now that the nation’s biggest banks have returned the money the government provided to keep them from collapsing, readers are wondering if those banks needed the money in the first place.

To be sure, the return of the money indicates that the bailout succeeded. Banks are healthy enough to give the money pack, and taxpayers didn’t have to foot the bill for their mistakes.

If only that were how the so-called TARP program really worked.

Wasn't the crux of the bailout money to provide the banks with money to lend out and move the economy? If the "too big to fail" banks are paying that money back, did they use it for the intended purpose or are they just handing back the money to get out from the restrictions/oversight associated with it?- Lorri W., Alaska

Was there really anything wrong with the banks? Just seems improbable that they could recover so quickly given all the foreclosures, defaults on credit cards, car loans etc. Maybe it was all a hoax.
- Tom C., Virginia Beach, Va.

The Troubled Asset Relief Program may have turned out to be a nightmare, but it wasn’t a hoax. Enacted in the depths of the worst financial panic since the 1930s, the law was supposed to fund government purchases of hundreds of billions of bonds backed by soured mortgages. Those failed investments swamped banks with losses and threatened to bring down the financial system we all rely on.

It’s next to impossible to know what would have happened if TARP money hadn’t been available because it’s not possible to predict the exact outcome of a global financial panic. It’s entirely possible the banking industry could have sustained major failures and kept lending. On the other hand, a widespread shutdown of credit — much worse than what we’ve seen in the past year — would have shut off the flow of capital that we all rely on in a modern economy. Once that flow shuts down, it can be extremely difficult to restart it.

In any case, the plan to buy up mortgage-backed bonds never happened. Treasury officials quickly realized the scheme was unworkable, largely because no one could figure out what these securities were worth. The government was the only buyer. If the Treasury set the prices too high, it would have lost tens or even hundreds of billions of taxpayer dollars. If it paid too little, the new “market” price could have forced banks to realize even bigger losses.

It’s also hard to predict what would have happened if a large commercial bank had been allowed to fail. When the financial system is functioning smoothly, the collapse of one large bank might be manageable. But in the fall of 2008 the system was in chaos. The potential for widespread damage was heightened by the collapse of Lehman Bros., the investment banking firm that was denied a government lifeline. The unexpected reverberations from the demise of that single, medium-sized Wall Street institution forced government officials to rethink their tough stance.

Congress also tried to hang tough, voting down the TARP measure the first time – only to watch global financial markets plummet on the news. A week later, the Treasury got its bailout.

With a $700 billion slush fund just sitting there, the government soon figured out lots of other ways to spend it. Some money did eventually find its way to the banking industry, in the form of government investments in preferred stock. That cash helped banks offset their mortgage-related losses.

In the meantime, bankers were getting much potent relief from the Federal Reserve, which dropped the banking industry’s cost of short-term money to as low as zero percent. (If you can’t make money acquiring money for free and then charging borrowers as much as 30 percent on credit card debt, you should probably find another line of work.) That interest rate windfall has been a much bigger tailwind for the banking industry that the TARP bailout. As they rebuild their cash base, bankers were only too eager to pay back TARP — and get the government out of their boardrooms. Just in time to set year-end bonuses.

Some TARP recipients didn’t recover and probably never will. The biggest of those is AIG, which transformed itself from a profitable insurance company into a risk-riddled casino with a huge portfolio of credit defaults swaps. Those insurance contracts were written to protect other financial institutions against losses from bad debts; when the mortgage market cratered, and AIG couldn’t cover its bets, the government stepped in with TARP cash and made good on them. The Treasury now estimates it will lose at least $30 billion from its AIG rescue. We’ll never know whether the recipients of those billions could have sustained those losses.

The list of bailout recipients doesn't stop there. Some $50 billion went to try to save the auto industry through partial government takeovers of General Motors and Chrysler. In theory at least some of that money will come back to the Treasury as the companies are overhauled and continue restructuring. GM is expected to eventually sell stock to the public again, but that could be years away.

Another $75 billion was supposed to help stop the home foreclosures that are deflating the value of mortgage-backed bonds. That part of the plan has done little so far to stem the tide.

As of last month, two years after the government began trying to help homeowners, some 31,000 loans had been permanently modified. There were roughly 4 million foreclosures this year alone. Another 3.5 million homeowners are seriously in default. Without real relief, another 3 million are expected to default over the next two years. Until the lending industry gets serious about its foreclosure problem, it faces continued losses for years.

The story of the TARP fund, which was to have expired at the end of the year, isn’t over. Using a clause slipped into the law during the darkest hours of the panic, Treasury Secretary Tim Geithner has extended the program through October 2010.

Congress is already talking about using some of the money to extend unemployment benefits. The banking industry still faces the prospect of defaults on a huge pile of commercial real estate debt that needs to be refinanced in the next few years. Federal mortgage providers Fannie Mae and Freddie Mac are essentially broke.

So the government has the better part of another year to dream up more ways to spend hundreds of billions of dollars in a program that never spent a dime on the problem it was created to solve.